On September 24 of last year, the financial regulatory authorities of China unveiled a series of groundbreaking policies aimed at providing financial support for the economy to develop at a higher qualityThese strategies included lowering deposit reserve ratios, adjusting policy interest rates downward, and consequently driving down the market benchmark interest ratesThese moves acted like a revitalizing shot in the arm for the Chinese economy, which was already teetering on the edge of deflation, sparking a long-awaited rally in the stock market.

At the Central Economic Work Conference in December, officials reaffirmed their commitment to stabilizing the real estate and stock markets while implementing more proactive macroeconomic policiesThese policy reversals targeted several glaring pain points of the current economy, including the stock market, real estate sector, and private enterprises, leaving many pleasantly surprised and hopeful for what the future might hold.

However, the real challenge lies in how these proactive macroeconomic policies can effectively reach the microeconomic entities and ignite their vitality and momentum

If the blockages within the conduits of economic transmission are not addressed, the financial lifeblood will struggle to reach these entities situated at the economic periphery, rendering the liquidity provided by the central bank ineffective in alleviating the immediate liquidity challenges facing these entitiesFurthermore, this could potentially sow the seeds for future stagflation.

It is crucial to recognize that many of the issues currently faced by enterprises are fundamentally linked to liquidity challengesTo truly grasp the origin of this liquidity crisis, it is necessary to reflect on a decade's worth of financial developments and economic conditions within China.

Starting with the dramatic rise and fall of the "leveraged bull" stock market in 2015, we observe a pivotal momentIn 2014, regulatory authorities failed to fully understand the illegality and potential hazards of off-market financing systems like HOMS (a combination trading system primarily utilized for efficient trading strategies, risk management, and data analysis) that featured a “tent-like” structure for distributing shares

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In a certain sense, they tacitly allowed these products to operate beyond the bounds of regulations.

Many underground financing firms offered leveraged trading through delegated management or revenue swaps, quickly amplifying leverage and pushing the stock market beyond the 5000-point mark.

By the latter half of 2015, when regulatory bodies recognized the unfolding problems, they adopted blunt measures to rectify the HOMS system, leading to substantial declines in the stock market and significant financial risks emergingFollowing the market turmoil, the financial industry underwent rigorous deleveraging alongside heightened regulation.

The introduction of new asset management regulations in 2018 profoundly impacted both the financial industry and the Chinese economy as a whole.

One of the primary objectives of these new regulations was to clarify financial products, simplifying it down to a common adage: "money meant to buy soy sauce cannot be used to buy vinegar."

From 2009 until the introduction of these regulations, numerous private enterprises relied heavily on “shadow banking” or off-balance-sheet banking services to secure the “liquid assets” necessary for their operations

This reliance emerged in tandem with the formal financial system's deficiencies in catering to the funding needs of private enterprisesHowever, the asset management regulations severed this line of credit, leading to a wave of risk events, especially for large and medium-sized private enterprises that had previously relied heavily on off-balance-sheet financing.

The ensuing financial tumult prompted a panic-driven contraction in funding for private enterprises, propelling a cycle of “contraction-exposure-contraction-exposure.”

Despite the repeated assurances from the Central government expressing concern over the difficulties and high costs of financing for private businesses, the stringent regulatory framework inadvertently blocked many indirect financing options, while the direct financing market was not easily accessible

Consequently, the channels through which financial resources could flow into private enterprises became constrictedWhile the central bank infused vast amounts of liquidity into the financial system to bolster economic development, the fruits of this liquidity were seldom seen by private and small enterprises.

Another primary intention behind implementing these new regulations was to facilitate deleveragingThe need for deleveraging became evident as the debt levels of local governments and state-owned enterprise platforms soared in recent years, alongside widespread occurrences of defaultsYet, the regulations produced an almost paradoxical result by stripping away the leverage from private enterprises that did not possess excessively high overall leverage ratios, inadvertently directing more funds towards state-owned enterprises and local governments.

Over the years, across bond markets, bank loans, and non-standard financing, the proportion of financing reaching private enterprises consistently declined, at times even plummeting dramatically

In the face of ongoing failures among private companies, financial institutions morphed into skittish entities, retreating from engaging with private businesses, while in some instances, only extending credit to state-owned enterprises and governmental platforms.

The deteriorating credit conditions surrounding private enterprises not only adversely affected the well-performing ones but also triggered a drain on productive capabilities, consequently imposing immense pressure on economic growth and social employment.

China maintains the world's largest total money supply (M2), now amounting to $40 trillion, which is double that of the United States; and the current M2 to GDP ratio stands at an astonishing 232%, significantly surpassing ratios in both the US and Germany, which fail to reach 100%. Meanwhile, the spread between M2 and M1 is expanding, with M1 remarkably experiencing prolonged contractions and year-on-year declines.

However, a larger money supply does not equate to greater liquidity

The aforementioned indicators reveal that to produce the same GDP, China is required to leverage twice the amount of currency compared to the USThis disparity arises from an abundance of "idle" money—either stored away as M2 in state accounts or trapped in convoluted financial instruments yielding a mere 2.5% over a 30-year termMeanwhile, numerous private enterprises and citizens experience a severe lack of liquidity, which raises questions about how robust employment levels and vibrant consumer behavior could emerge under such circumstances.

Another critical factor contributing to contemporary liquidity challenges for enterprises stems from the near-total collapse of several private real estate companiesOver the past decade, local governments ramped up land supplies in attempts to stabilize property prices, and policies mandating land-use urgency alongside land value taxes coaxed the real estate sector into a realm of rapid turnover and high leverage, birthing numerous latent risks.

As continued regulatory measures culminated in the infamous “three red lines” policy, the financial chains of the industry could barely hold up, leading many prominent private property developers to face ruin, including the once illustrious Vanke, which has now fallen into severe distress.

Whether recognized or ignored, the fact remains that real estate is an unassailable pillar of the national economy, and its abrupt decline inevitably yields monumental repercussions for the broader economy.

The fallout from real estate failures has resulted in numerous stalled projects, with safeguarding the completion of housing developments becoming a pressing concern for local governments

However, measures to ensure project completions have led to more stringent financial regulations, compounding the financial strain on real estate enterprises, and constraining the sector’s recovery efforts.

The contribution of the property sector and its directly related industries exceeds 25% of GDP; thus, the severing of financing chains within real estate will unavoidably instigate a cascade of failures among numerous upstream and downstream businesses, some of which may declare bankruptcy and result in widespread unemployment.

In household balance sheets, real estate represents the most significant asset, roughly accounting for 70% of total family assetsA downturn in the property market leads to a direct depreciation of familial wealth, especially for those families that have leveraged their assets; the resultant debt burdens can directly strain their current lifestyles and engender fears of default on obligations

Such developments also shift public expectations regarding housing prices and, consequently, future housing demand.

In addition to being a central component of the national asset balance sheet, real estate also serves as a crucial carrier of social wealthA decline in housing prices and wealth erosion may provoke a debt crisis and usher in deflationary threatsDeflation is often considered more perilous than inflation and may lead to economic stagnation, a sentiment eloquently illustrated by Japan's prolonged economic malaise over the past three decades.

Currently, the liquidity crises experienced by private enterprises and real estate companies not only pose threats to their survival but also unavoidably impact societal stabilityIt is imperatively necessary to inject liquidity directly into private enterprises, real estate businesses, and households as a means to disrupt the established patterns of deflationary expectations.

In light of stringent regulatory guidelines and rigorous audit accountability that have strained credit creation mechanisms, resulting in a partial breakdown of resource allocation functions within finance, it is essential to decisively employ some “hard measures” to directly inject liquidity into desperately needed microeconomic entities, thus bolstering enterprise confidence and potentially reversing negative trends.